A few weeks ago, leading management consulting firm McKinsey & Company* published a fascinating report: Automotive revolution—perspective towards 2030: How the convergence of disruptive technology-driven trends could transform the auto industry. In its comprehensive analysis, McKinsey pointed to Tesla Motors as a "case study" for disruptive strategy critical to the transformation that lay ahead in the auto industry. And at the outset, McKinsey addresses the marketplace in general and warns: "there are many tough, fundamental, or even existential questions that are looming for automakers and suppliers."

That said, we wanted to extract McKinsey's key findings that pertain to Tesla Motors. Although the wide-ranging report discussed many issues, it placed an emphasis on software, self-driving features, and electric vehicles as keys that allow Tesla to have an enviable position in light of the industry changes fast-approaching. First, the report explains: "software competence is increasingly becoming one of the most important differentiating factors for the industry. The program code for the modern car has approximately as many object instructions as an aerospace flight control system." Certainly Tesla CEO Elon Musk's experience as CEO of aerospace giant SpaceX can't hurt here.

McKinsey further emphasizes the critical role of in-house software expertise in its report: "OEMs need to build up skills for software development to match their new competitors’ capabilities and fulfill new requirements (e.g., cyber security, faster innovation cycles). This involves moving to a software development model based on top, in-house talent in an agile and fast-paced development structure, complemented by the capabilities of partners in a common ecosystem. This structure allows for tighter end-to-end control over user experience. Companies like Tesla, Google, and Apple develop most of their core software themselves, but generally, OEMs have outsourced large parts of their software development."

This dovetails into something similar that Morgan Stanley referenced in a controversial (and important) video it published on Tesla Motors. In the video, Morgan Stanley explains that, "Around 60% of Tesla employees are involved in software engineering versus a normal auto company at around 2%. This is important because the value add of software in a car rises from 5% today to over 60% in the next decade."

Furthermore, McKinsey reports: "Connectivity, and later autonomous technology, will increasingly allow the car to become a platform for drivers and passengers to use their transit time for personal activities, which could include the use of novel forms of media and services. The increasing speed of innovation, especially in software-based systems, will require cars to be upgradable." This was so important in McKinsey's overall analysis that they included a breakout report with a special case study on Tesla: Case example: Tesla upgrades its cars like Apple updates iPhones – over the air.

McKinsey's Tesla Case Study notes that: "Just as Apple and Google are continuously upgrading their operating systems for customers, Tesla is pushing free over-the-air upgrades... The way that Tesla has set up its software and distribution makes it easier for them to push frequent over-the-air updates to their vehicles. Tesla develops its software in-house and designed a software architecture suitable for over-the-air upgrades right from the beginning... software updates are beneficial for both Tesla and their customers: while drivers receive software updates with new functionalities that make their cars more valuable, Tesla uses these customer touch points as a way to increase satisfaction and loyalty and gather fleetwide performance data."

Also in the report, McKinsey notes: "Autonomous technology and electrified powertrains are generating plenty of interest and we see strong long-term potential… Tech players and start-ups will likely play an important role in achieving this level of technical complexity." With Tesla's superior autopilot capabilities and its core competency in electric vehicles, it's clear they have a distinct advantage on both fronts.

Mckinsey reports that, "Electrified vehicles are becoming viable and competitive... and electrified vehicles are expected to gain more and more market share from conventional vehicles. With battery costs potentially decreasing to USD $150 to $200 per kWh [kilowatt-hour] over the next decade, electrified vehicles will achieve cost competitiveness with conventional vehicles, creating the most significant catalyst for market penetration. Advances in charging technology, range, and awareness will further improve the customer value proposition."

And with Tesla's current efforts to reduce battery costs at its massive Gigafactory, Goldman Sachs analysts just reported that Tesla "representatives said $200 per kilowatt-hour is about where they [Tesla] are right now, and they’re targeting less than $100 per kilowatt-hour per pack."

It was clear after reading McKinsey & Company's report that Tesla's business strategy is uniquely equipped to take on the automotive revolution that lay ahead. It's heavy emphasis on software, self-driving features, and an all-electric vehicle strategy allows Tesla to own a distinct (and significant) advantage as we move towards a transformational period in the automotive sector.

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